Delaware Court of Chancery Finds Supermajority Director Removal Bylaw Invalid

Delaware Court of Chancery Finds Supermajority Director Removal Bylaw Invalid

The Delaware Court of Chancery recently invalidated a corporate bylaw provision requiring 66 ⅔ percent of the voting power of all the corporation’s outstanding shares to remove directors, finding it was inconsistent with the Delaware General Corporation Law (DGCL).

Background

Nutrisystem Inc. announced in January 2016 that it had approved an amendment to the company’s bylaws which struck a requirement that directors could only be removed “for cause.” The amendment left intact a portion of the bylaw requiring a supermajority vote of at least 66 ⅔ percent of voting power of all outstanding shares in order to remove directors.

Harold Frechter, a Nutrisystem shareholder, filed a lawsuit in February 2016 alleging the directors breached their fiduciary duty by enacting an unlawful bylaw to entrench themselves in office. He also sought declaratory judgment that the removal provision violated the DGCL.

The plaintiff later stipulated he would withdraw Count I if the court found in his favor on Count II. In a decision Jan. 24, Vice Chancellor Sam Glasscock III granted Frechter summary judgment on Count II and found Nutrisystem’s removal provision was inconsistent with Section 141(k).

Decision

Defending the bylaw, Nutrisystem pointed to Section 216 of the DGCL, which allows corporations to adopt bylaws specifying the required vote for the transaction of the business of the corporation “[s]ubject to this chapter in respect of the vote that shall be required for a specified action...” Nutrisystem argued Section 141(k) “sets the rules only for the circumstances under which stockholders may remove directors without cause, and does not address the percentage of the vote that is required to remove directors.” In effect, it said nothing in section 141(k) prevented the board, under Section 216, to set a supermajority requirement of directors in the bylaws of the company.

Vice Chancellor Glasscock rejected this argument and called it an “unnatural reading” of Section 141(k). “The section provides that holders of a majority stock may - not must - remove directors; that is if they so choose, the section confers that power. Obviously, the need not exercise the power at any given time: they ‘may do so. Under the Removal Provision, however, a simple majority of Nutrisystem stockholders may not exercise such power; the bylaw is, unambiguously inconsistent with the statute.”

The judge also said that Nutrisystem’s reading of the statute was inconsistent with other recent court decisions. For example, in In Re VAALCO Engery Inc. Stockholder Litigation, the Chancery Court found that Section 141(k)’s language providing that directors may be removed with or without cause prohibits bylaws requiring cause for that purpose. “Likewise, Section 141(k) also mandates that a majority of stockholders may remove directors,” the vice chancellor wrote.  

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